Arbitration lawsuits just keep coming. In one of the latest, the California Court of Appeals found yet another employment arbitration agreement unenforceable, this time because a modification clause gave the employer the right to modify or revoke the agreement on 30 days’ notice to the employee. Read on to learn the right and wrong ways to formulate modification clauses.

Salesperson sues store

“Herb” is a gay Jewish male of Israeli national origin. He was a salesperson in the fragrances department in the Beverly Hills Neiman Marcus store from December 28, 2005, to February 21, 2008. His supervisor was an Iranian woman of the Muslim religious faith.

After Herb was fired, he sued Neiman Marcus under the state Fair Employment and Housing Act (FEHA). Herb claimed he was terminated, harassed, and subjected to retaliation because of his national origin, religion, and sexual orientation.

The employer asked the trial court to compel arbitration on the basis of a mandatory arbitration agreement. The trial court put the judicial proceedings on hold and sent the case to arbitration. The arbitrator ultimately ruled in the employer’s favor and awarded it sanctions of more than $40,000 in attorneys’ fees and expenses. The trial court confirmed the award, and Herb appealed.

Modification clause kills the contract

The arbitration agreement included a modification provision stating that the employer could amend, modify, or revoke the arbitration contract on 30 days’ written notice; at the end of the 30-day period, the contract change would apply to any claim that hadn’t yet been filed with the American Arbitration Association (AAA).

On appeal, Herb contended that the clause made the arbitration agreement unenforceable, and the Court of Appeals agreed. The court found that the modification clause gave the employer the unilateral right to amend, modify, or terminate the arbitration process, with any change applied to all unfiled claims.

The Court of Appeals also faulted the modification clause for creating two categories of claims: those filed within 30 days of notice (the protected category) and those that have accrued or are known to the employer but are not filed within 30 days (the unprotected category).

The court found that the agreement should have exempted not just filed claims but also claims that had accrued or were known to the employer and weren’t filed within 30 days. By not doing so, Neiman Marcus had the unfettered unilateral right to modify the arbitration process or terminate the agreement for those claims. In other words, it could pick and choose the claims it wanted to arbitrate.

The Court of Appeals reversed the trial court’s order compelling arbitration and the arbitration award, and held that Herb’s case must be heard in court.

The Lone Star State vs. the Golden State

Notably, because of a choice of law provision in the arbitration agreement, the Court of Appeals applied Texas law to decide the case. But the court also determined that the Texas law would not conflict with any fundamental policy of California.

In fact, probably to the surprise of many California employers, the court found that Texas law on this issue is more demanding than California law.

Under Texas law, an arbitration agreement that contains a modification provision must expressly state that a change in the agreement will not apply to a claim that has arisen or is known to the employer. Under California law, on the other hand, a court may imply such a restriction—and thereby uphold an arbitration agreement—if the agreement is silent on the issue.

Check your agreement

This is a good time to review your arbitration agreement. If it includes a modification clause, make sure the clause clearly states that any changes will apply prospectively only and not to any claims that arose or were known about before the date of the change. There’s a chance a California court will imply this restriction even if it’s not included, but why take the risk? Peleg v. Neiman Marcus Group, Inc., Calif. Court of Appeals (Dist. 2) No. B231634, (2012)

Practice Tip: Modification clauses in arbitration agreements that give employers the unfettered unilateral right to change the arbitration process or terminate the agreement won’t stand up to judicial scrutiny.